Mohammed’s paper serves as a call to all governments to engage in active dialogue with the investment community in a serious attempt to think more carefully about the hidden costs of excess liquidity in DC pensions.
Zuhair Mohammed, 300 Club, said: “The cost of excess liquidity in DC pensions to tomorrow’s pensioners and to society as a whole is significant and governments, as a minimum, have a moral obligation to create transparency around this issue and educate investors about the hidden and unrewarded trade-off of excess liquidity, which will be felt both financially and in their quality of life.
“If governments and pensions regulators consider improving savers’ outcomes to be one of their key goals, then they really should be more interested in exploring the true cost of the liquidity that is unnecessarily imposed on member,” Mohammed continues.
In his paper Mohammed questions whether daily dealing is really necessary when research shows few savers take advantage of the level of liquidity regulatory frameworks currently impose.
Mohammed argues: “The move towards daily trading has no basis in sound reason from a typical member’s perspective. People have been lured into thinking the perceived greater efficiency is good, but, in the rush for ever-more rapid trading, they are not thinking about the impact it would have on investment outcomes.”
Insisting on daily liquidity has “a material impact on retirement outcomes,” Mohammed argues. Forgoing the illiquidity premium presents a significant cost to DC member and even where liquid versions of alternative asset classes exist, they could cost savers as much as five to ten percent over the average life time of a pension pot compared to illiquid investments offering true economic exposure to alternatives such as real estate, hedge funds, private equity and infrastructure.
Mohammed also points to research from the investment industry showing DC pension funds are missing out on both the illiquidity premium and opportunities for diversification, which could cost them as much as five percent of additional pension savings.
Furthermore, Mohammed also warns against the unintended consequences of charge caps, which, he says, “make matters worse” by encouraging cheap and cheerful asset management, leading to a situation where intelligent and well-diversified strategies are given up in exchange for passive investments in large stocks.
Society at large is also a loser from excess liquidity in DC schemes, Mohammed argues, because it restricts illiquid investments, many of which are good for the economy and society.
This impact is often overlooked, according to Mohammed: “Retiring into a world that lacks the cumulative economic and societal benefits of infrastructure spending over an extended period, would materially change the quality of life today’s savers would experience in their retirement.”